In election year, a wake up call from World Bank for India's politicians

So the Sensex is upbeat about positive global economic outlook set out in World Bank's latest Global Economic Prospects report. Soon the government's economic managers will also start waving the report as testimony to the fact that they have managed to get the economy to turn the corner.

But the optimistic note is accompanied by a very clear warning. "Entrenchment of inflation expectations in India could reduce space for monetary easing and adversely affect investment. Lack of progress in reducing supply-side constraints (particularly in electricity, infrastructure and agricultural sectors) could also pose significant downside risk to the outlook."

But with the country moving a step closer to elections every single day, will politicians indulging in economically ruinous competitive populism take heed? Delhi's chief minister Arvind Kejriwal has already set the tone with cheaper water and power tariffs, prompting two Congress MPs in Maharashtra to demand that their state government do the same. The refrain is sure to be picked up by others as well.

 In election year, a wake up call from World Bank for Indias politicians

With the country moving a step closer to elections every single day, will politicians indulging in economically ruinous competitive populism take heed? Delhi's chief minister Arvind Kejriwal has already set the tone with cheaper water and power tariffs, prompting two Congress MPs in Maharashtra to demand that their state government do the same. Reuters

There is, the report says, no room for a business-as-usual policy. "Policy complacency risks a further accumulation of domestic vulnerabilities likely requiring larger adjustments down the road, and at greater economic cost given the closer scrutiny of domestic risks by financial markets," the report says.

The report, titled, Coping with normalization in high-income countries, assesses how a firming up of growth in the high income countries and the tapering of quantitative easing by the United States could affect the global economy. Much will depend, it says, on how the tapering proceeds. If it does so in an orderly manner - with global interest rates rising slowly - the impact on developing countries could be modest. Capital flows to these countries could drop from 4.6 percent of combined GDP in 2013 to 4.1 percent in 2016. That could give countries time to make the necessary adjustments, without too many upsets.

But if - and this is a big if - interest rate hikes in the developed countries are sharp, then the greenbacks will hotfoot it to those markets in what the Bank calls `a disorderly adjustment scenario'. In such a situation, the report warns, financial flows to developing countries could decline by as much as 80 percent in several months, falling to about 0.6 percent of developing-country GDP. "In the event, nearly a quarter of developing countries could experience sudden stops in their access to global capital, substantially increasing the probability of economic and financial instability."

There are ways to neutralize this impact. "The ability to withstand such shocks will depend crucially on domestic vulnerabilities and policy buffers, with some countries better placed to navigate these headwinds," the report says. The countries that are better placed are those with relatively lower levels of inflation, government deficits and current account deficits. So Mexico's currency decline was smaller than that of Brazil even though the latter's economy grew 6 percent while the former's declined. Similarly, Chile and Malaysia have coped better than Brazil and India where macro-economic management was tardy.

In such a situation, can a country afford to send out wrong signals by reversing decisions on opening up sectors to foreign investment (as Kejriwal has just done) or continue ratcheting up the subsidy bill? The report clearly warns that the higher growth it has predicted be jeopardized by policy reforms being stalled or reversed. Limited fiscal space, it warns, will make it difficult for domestic economies to respond forcefully to intensification of crises, while an inability to maintain fiscal discipline and to reduce subsidies could adversely affect sovereign creditworthiness.

Kejriwal and some other chief ministers may not be reading World Bank reports but finance minister P. Chidambaram does keep himself abreast of such matters. Will he pay heed, even as his mandarins juggle numbers to keep the fiscal deficit artificially low? Will credit rating agencies not be wisening up to these tricks?

Problems caused by tighter financial conditions can get offset by better trade prospects as consumption demand in the high income countries improves, the report notes. India's exports have been picking up of late, but they are still far from being competitive in the global market. Increasing competitiveness will again require a slew of domestic reforms that the country has been postponing endlessly.The report has a clear message for Indian policy makers and implementers - global headwinds can be met head on if the domestic economy is strong. That will mean far more responsible behaviour than they are used to. Will that be possible? Or is the Indian economy doomed to go into reverse gear?

Updated Date: Dec 21, 2014 02:55:16 IST



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